Teaching Myself Economics, Part II

Editor's note: Yesterday, Digest contributing editor P.J. O'Rourke explained how he first became interested in economics.

In today's Masters Series essay – originally published in the August 19 Digest – P.J. shares his top 10 basic principles of economics...

Teaching Myself Economics, Part II

As I said in "Teaching Myself Economics, Part I," I started out as a former college English major who, when it came to economics, couldn't tell bird poop from sugar frosting.

I tried learning the "basic principles of economics" by reading econ textbooks and discovered I was still smearing pigeon droppings on my cupcakes.

Then I found a few economists who made sense. And more important, I began to apply my own common sense and powers of observation to economic activity.

As it turns out, the basic principles of economics found in econ textbooks aren't very useful. But 10 "other principles of economics" are much more helpful. Here are my top 10...

1. The market is never wrong.

A thing is only worth what people will give for it.

Apple (AAPL) is a great company. If you have some Apple shares and try to sell them on the Nasdaq exchange for $1,000 apiece, you may be brilliant. Apple stock may be worth $1,000, easy. And all the people trading stock on the Nasdaq may be fools for valuing Apple at just $110 a share. A Mac is a much better computer than a PC. But smart as you are, and dumb as everybody else is, the market says your shares didn't sell. And the market is right.

(Also, a thing may be "priceless." You would rather die than trade your Mac for a Dell. But death is still a price, just a very high one.)

2. So you die. Things still cost what they cost.

There's no use in trying to fix prices. To do so, you have to have a product that can't be replaced, and you have to have complete agreement among all the people who sell that product. But the sellers are greedy, otherwise they wouldn't have gotten into the agreement. And greedy people will try to sneak out of that deal as soon as it benefits them.

Any drug dealer can tell you that to ensure a monopoly, you need force. To ensure a large monopoly, you need the kind of force only a government has. And it still doesn't work.

When the price of something is fixed below market level, that something disappears from the legal marketplace.

And when the price of something is fixed above market level, the opposite happens.

Say the customers at Wheat Depot won't pay enough for wheat. The U.S. government decides to buy that wheat at higher prices. Suddenly, wheat is everywhere. People have bushels of it in the attic. The government is up to its nose in wheat. The wheat has to be given away. The recipients of free wheat in the Inner City Wheatfare Program hock the wheat at traffic lights, and what they get for it is exactly what people are willing to give.

3. You can't get something for nothing.

Everybody remembers this except politicians. Lately, we've heard one American politician promise that government revenue (taxes) can be cut while government benefits (expenditures) remain intact. Benefits might even get larger. This will be done through increased "efficiency."

I discussed efficiency in the first installment of this series. Efficiency increases only as a result of technological breakthroughs, like James Watt inventing the steam engine. Donald Trump is not going to invent the steam engine. Neither is any other politician. (Although, to the extent that steam is hot air, maybe I'm wrong.)

Politicians have trouble giving up the idea of something for nothing – it's such a vote-getter. A government can try to give most people something for nothing by taxing the people with money. But there are never enough of them. As Margaret Thatcher (one of the few politicians who did understand economics) said, "Sooner or later you run out of other people's money."

A government can also try to give all people something for nothing by simply printing more money. This doesn't work either because it makes all the money worth less, the way it's becoming worth less right now all over the world.

Inflation is a tax on the prudent, who watch the value of their conservative bank accounts and bond investments disappear. Inflation is a subsidy for scam artists who can borrow money for harebrained speculative schemes and pay it back later with money that has no value. And inflation is a punishment to the old and the poor, who live on fixed incomes and can't expect to get a big cost-of-living adjustment retrieving soda cans from trash baskets.

Finally, a government can try to give us something for nothing by running a deficit, by borrowing money from us and then giving it back. This is obviously stupid and is exactly what we've been doing for decades in the United States.

Deficits are less immediately painful than high inflation or huge taxes, although eventually they lead to both. In the meantime, we aren't getting anywhere. If all our investment money is tied up in loans to the government, that money is going to be spent on government things, such as financing the Inner City Wheatfare Program. Our investment money can't be spent on research and development to create, for example, a genetically engineered wheat-eating squid to turn that worthless wheat into valuable calamari.

4. You can't have everything.

If you use your resources to obtain a thing, you can't use those same resources to obtain something else. That's called fraud (or having a credit card).

In economics, it's called "opportunity cost." When you employ your money, brains, and time in one way, it costs you the opportunity to employ them in another.

Opportunity costs fool people because they're unseen. When we observe money being spent, we're impressed. We gasp with awe at the huge new Federal Wheat Council headquarters in Washington, D.C. We don't admire the vast schools of genetically engineered squid feeding in our nation's wheat fields – because they aren't there. The main cost of government expenditure is not taxes, inflation, or interest on the national debt. It's opportunity.

5. Break it and you bought it.

Being fooled by hidden costs is the source of a lot of economic confusion. War is often spoken of as an economic stimulant. World War II "pulled America out of the Depression." Germany and Japan experienced "economic miracles" after the war. Somebody is not counting the cost of people getting killed and wounded. Besides, if destruction were the key to greater economic productivity, all the investors in the world would be investing in Syria.

6. Good is not as good as better.

Almost as bad as costs that go unnoticed are benefits that get too much attention. It's great if everybody has a job. But computers are taking jobs away. So we could guarantee full employment if we removed computers – and electricity – from the communication industry and hired people to run all over town and fly around the world, telling our friends and business associates what we want to say.

When James Watt invented that steam engine, thousands of 10-year-old boys who had been hauling coal carts were put out of work. However, this left them free to do other things, such as live to be 11.

7. The past is past.

Another thing that gets too much attention is money that has already been spent. In economics, this is called "sunk costs." It doesn't matter that you blew everything you made selling Apple at $1,000 a share on a scheme to genetically engineer wheat-eating squid. What matters is whether you can make any money off those squid now or convince people that the squid will make money in the future, so that those people will buy the fool company.

This is called "marginal thinking," and in investing it means the exact opposite of what we usually mean when we call somebody's thinking "marginal."

8. Build it and they will come.

It was Ralph Waldo Emerson who is believed to have said, "The world will beat a path to your door." He was referring to what would happen if you built better mousetraps. That tells us something about home hygiene and housing conditions in the 19th century.

The underlying notion is stated formally in economics as "Say's Law" (from the French economist Jean-Baptiste Say): "Supply creates its own demand." More is better. Any increase in productivity in a society causes that society to get rich enough to buy the things that are produced.

This works even in an economy as screwed up as communist Cuba's. The communists have allowed limited free-market sales of food. This has increased food production. Despite the extreme poverty of Cubans, that food does not sit around unsold.

9. Everybody gets paid.

People want to get something for what they do, although what they want to get may not be money. What they want may be love or a sense of their own virtuousness or to be treated like a big shot at the local bar. Every activity is a business.

This is the "public choice" theory of economics. One of its founders, James M. Buchanan, won the 1986 Nobel Prize in economics for his work on understanding politics as an economic enterprise.

Politicians don't measure profits in cash. The gain that they want is an increase in power. Thus, socialists like Bernie Sanders turn out to be just as greedy – or even more so – than hedge-fund managers.

In order to increase their "power income," politicians have to pass more legislation, expand bureaucracies, and broaden the scope of government power. A politician who claims he is going to cut the size of government is saying he is going to creep up on himself and steal his own wallet.

10. Everybody is an expert.

Of all the principles of economics, the most important to making us richer (or more powerful, or whatever) is specialization, or as Adam Smith, who discovered the principle, called it, "division of labor."

Milton Friedman used a pencil as an example. A pencil is a simple object, but no single person in the world can make one from scratch.

The pencil maker would need to be a miner to get the graphite, a chemical engineer to turn graphite into pencil lead, a lumberjack to cut the cedar trees, and a carpenter to shape the pencil casing. He would need to know how to make yellow paint, how to spray it on, and how to make a paint sprayer. He would have to go back to the mines to get the ore to make the metal for the thingy that holds the eraser, then build a smelter, a rolling plant, and a machine-tool factory to produce equipment to crimp the thingy in place. And for the eraser itself, he would have to grow a rubber tree in his backyard. All this would take a lot of money... Yet a pencil sells for $0.17.

No. 10 in the list of "other principles of economics" makes it clear that if you're looking for expertise in economics, an econ professor isn't the right person to ask. For that matter, neither am I. The real expert about your economic situation is always you.


P.J. O'Rourke

Editor's note: P.J.'s latest book – Thrown Under the Omnibus: A Reader – drew rave reviews on Amazon. One reader called it "hours and hours of enjoyment and laughter." Grab a copy here.